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Capital Allocation Trends At Tower Semiconductor (NASDAQ:TSEM) Aren't Ideal

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There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Tower Semiconductor (NASDAQ:TSEM) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Tower Semiconductor, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.05 = US$91m ÷ (US$2.1b - US$273m) (Based on the trailing twelve months to December 2020).

Therefore, Tower Semiconductor has an ROCE of 5.0%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 10.0%.

See our latest analysis for Tower Semiconductor

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In the above chart we have measured Tower Semiconductor's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Tower Semiconductor here for free.

How Are Returns Trending?

In terms of Tower Semiconductor's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 11%, but since then they've fallen to 5.0%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

What We Can Learn From Tower Semiconductor's ROCE

Bringing it all together, while we're somewhat encouraged by Tower Semiconductor's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 157% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

While Tower Semiconductor doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

While Tower Semiconductor may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.